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Everything You Need to Know About Advisor-Sold 529 Plans

Victor AlifieriJul 18, 2019

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According to financial calculators on www.finaid.org, the tuition for a public 4-year college when a child born this year enrolls, will cost well over $50k a year. Even in this financial environment, it is not only possible, but extremely helpful to invest in a 529 Plan, which is one of the best college savings plans. Used correctly, it can be a very useful tool for college planning and reaching your long-term goals. Read on to learn about 529 plan rules.

College Savings Plans: What is a 529?

According to the SEC website, a 529 plan “is a tax-advantaged savings plan designed to encourage saving for future college costs. 529 plans, legally known as “qualified tuition plans,” are sponsored by states, state agencies, or educational institutions and are authorized by Section 529 of the Internal Revenue Code.”

You can find two different ways these 529 savings plans work. “Pre-paid” plans allow you to purchase tuition “credits” at current rates to be used in the future. Generally, these types of plans are purchased directly from universities or state programs and can only be used at those institutions.

“Savings” plans are the more common products. Mutual funds are used to invest in the market. The growth in the account is based on market fluctuations.

Benefits of Investing

Contributions are not federally tax deductible, but any distributions used for qualified college expenses are tax free. If your state offers a college 529 Plan, there is a further incentive, in that it is usually state tax deductible. Be aware though. Not all states give this deduction, and if so, the state approved 529 college savings plan may not be the best investment. Shop around at other states to find a better option.

The amount that is actually deductible could be different with each state, but the amount you can contribute to a 529 Plan is based on gift tax laws. Currently $14,000 can be contributed annually without incurring any tax costs. You can also contribute 5 years worth ($70,000) in a lump sum, provided that there are no other gifts from that person in that time period.

There are four things to check into before picking a state 529 Plan, even if your state does offer tax incentives:

Minimum Investment – Each state varies, and some require a monthly automatic deposit.

Investment Options – These vary widely since each state has its own 529 plan. In most cases, these plans are run by mutual fund companies that offer a wide range of mutual funds. These could be purchased two different ways: directly from the state, or through a financial advisor.

Expenses – Here is where an investor needs to pay attention. Generally, when you purchase a 529 plan directly, there is an annual maintenance fee and a small expense fee built into the investment itself. When you purchase a 529 plan from an advisor, you are charged a “load” or a commission. This charge can be as much as 5.00% or higher depending on what share class you purchase. The expenses of the funds in the plan are also higher.

The Different Share Classes

Typically, there are three different share classes for mutual funds and 529 plans in general. The investment itself is exactly the same, the difference is in when you are charged that commission. See below for a 529 plan comparison:

A-Shares – The highest sales charge of all share classes, and it is paid up front. If the fee is 5% and you invest $1,000, $950 is what actually goes into the investment. Depending on how much you are investing, there are “breakpoints” that will bring this fee down. The expenses of the fund are usually lower, so for a long-term investor, this could be the best share-class for you.

B-Shares – This share class has what is called a contingent deferred sales load, or “back-end load.” The investor pays when they liquidate, based on how long they hold the fund. This will have higher expenses than the A-share and can be a very bad investment for anybody who needs the funds after a few years.

C-Shares – When you invest $1,000 in this share class, $1,000 goes into the investment. The annual expenses of this class are higher than the A-share, which can make it more expensive over time. If you have a short time horizon or plan to move the money between funds, this will be the better share class.

Like other investments, there is a choice between using advisor-sold investments or handling it on your own. The decision is completely up to the individual here. The fees on the advisor-sold products are to compensate the advisor and the firm for their knowledge and guidance. If you are comfortable making your own investment decisions, then going the DIY route will most likely be the best option.

Withdrawals

Withdrawals used for “qualified” college expenses will be penalty-free, but what is considered qualified?

Any expenses incurred in the enrollment and attendance of an eligible school (colleges, universities, accredited post-secondary schools and vocational schools)

Tuition/fees

Books, supplies, equipment

Room and board (usually on campus. Off site apartments aren’t usually covered)

Transportation

Uniforms

Tutoring

Any special needs expenses

If a withdrawal is made for a non-qualified purpose, that distribution can be taxed as ordinary income and also be hit with a 10% penalty. There are special circumstances where these penalties can be waived however.

529 accounts can be moved from one beneficiary to another. For example, your oldest child may win a scholarship. You can change the beneficiary on the plan to a younger child, niece, nephew or even yourself.

The Bottom Line

Whatever you do, decide to start now. It’s never too late to begin saving for college and you will thank yourself for it in the future. Many of the major investment sites like Morningstar and Kiplinger’s have resources such as 529 plan calculators and 529 plan rankings for college savings accounts. Additionally, www.savingforcollege.com is a great site to start.

A matching tool like SmartAsset’s SmartAdvisor can help you find a person to work with to meet your needs. First you answer a series of questions about your situation and goals. Then the program will narrow down your options from thousands of advisors to three fiduciaries who suit your needs. You can then read their profiles to learn more about them, interview them on the phone or in person and choose who to work with in the future. This allows you to find a good fit while doing much of the hard work for you.